Standing Committee A

[Sir John Butterfill in the Chair]

Finance Bill

(except clauses 4, 5, 20, 28, 57 to 77, 86, 111 and 282 to 289, and schedules 1, 3, 11, 12, 21 and 37 to 39)

Clause 47 ordered to stand part of the Bill.

Schedule 7 - Insurance companies etc

Ruth Kelly: I beg to move amendment No. 86, in
schedule 7, page 281, line 42, after first '14' insert 
 ', 17, 22, 31 or 38'.

John Butterfill: With this it will be convenient to discuss Government amendments Nos. 87 and 88.

Ruth Kelly: First, let me say what a pleasure it is to serve under your chairmanship, Sir John. I look forward to your guidance.
 Amendments Nos. 86 and 87 extend the scope of a relieving provision that we have included in the Bill. Last year, we introduced a package of anti-avoidance rules to prevent life insurance companies from exploiting the system when transferring their business to another company, usually in the same group. One of those rules was designed to prevent companies from leaving assets representing untaxed profits behind and then extracting them in a tax-free way when they ceased to be an insurance company. However, the provision went too far, and it has been pointed out that it could inhibit the restructuring of life companies for good commercial reasons if companies leave behind assets to meet liabilities to policyholders whom they are also leaving behind. 
 The Bill therefore allows liabilities to be set off against assets, and it describes the type of liabilities that count for that purpose. However, it now turns out that other liabilities may also be left behind.

Quentin Davies: On a point of order, Sir John. I mean no discourtesy to the Financial Secretary, and I hope that she will forgive me, but I can only just hear what she is saying, and I am certain that people further away cannot hear her. It is important that we are clear about what she is trying to tell us, and I would be most grateful if she could raise the volume just a little.

Ruth Kelly: I will be delighted to speak at greater volume.
 It now turns out that other liabilities may also be left behind. Amendment No. 86 therefore adds additional liabilities to the list. 
 Amendment No. 87 ensures that another related provision in the Bill works properly. The provision was designed to prevent companies from exploiting the relaxation of the retained assets rule, but it could work harshly where a company's genuine attempts to 
 estimate its liabilities to policyholders turned out to be overcautious. As long as the retained assets that are not needed to pay claims also end up with policyholders, no additional charge to tax will arise. 
 Amendment No. 88 makes some minor technical changes. It adds a few more examples of life assurance tax provisions where it has become desirable to clarify what is meant by something being referable to a particular category of life assurance business. The amendment makes it clear that referability is based on the rules in section 432A of the Income and Corporation Taxes Act 1988. Those are also the rules for the provisions that were originally included in paragraph 9 of schedule 7. The additional provisions were, however, accidentally left out. I therefore commend the amendments to the Committee.

Howard Flight: I, too, welcome you to the Chair, Sir John. We are pleased that the Government have introduced the amendments to deal with some relatively minor outstanding issues that needed to be dealt with. The industry is broadly content with the arrangements in clause 47 and schedule 7, and there is nothing to criticise.
 Amendment agreed to. 
 Amendments made: No. 87, in 
schedule 7, page 282, line 32, at end insert— 
 '(7) Where an amount is shown as post-transfer reduction liabilities in the transferor's accounts for any accounting period beginning after the transfer, this section applies as if the amount of the retained liabilities at the end of that accounting period (and the beginning of the next) were increased by the amount so shown. 
 (8) In subsection (7) above ''post-transfer reduction liabilities'' means liabilities of the transferor to make payments to relevant persons which, in accordance with the terms of the insurance business transfer scheme, have arisen in consequence of a reduction in the amount of the retained liabilities at any time after the transfer. 
 (9) In subsection (8) above ''relevant persons'' means— 
 (a) if the transferor's life assurance business immediately before the transfer was mutual business, persons who were policy holders or annuitants, or members of the transferor, at that time, and 
 (b) in any other case, persons who were policy holders or annuitants at that time.''.'.
 No. 88, in 
schedule 7, page 285, line 13, at end insert— 
 '(1A) In the following provisions of the Finance Act 1989 (c.26) (which relate to the policy holders' share of profits)— 
 (a) section 88(3A)(a), 
 (b) the words within quotation marks in the portion of section 88(3B) preceding paragraph (a), 
 (c) the portion of section 89(1B) preceding paragraph (a), and 
 (d) section 89(2)(b), 
 after ''referable'' insert ''(in accordance with section 432A of the Taxes Act 1988)''; and, in consequence of the amendment made by paragraph (b), in section 88(3B), for ''referable to that business'' substitute ''so referable''.'.—[Ruth Kelly.]
 Schedule 7, as amended, agreed to.

Clause 48 - Loan relationships: miscellaneous amendments

Question proposed, That the clause stand part of the Bill.

Howard Flight: This, which introduces schedule 8, and the next few clauses are what I would describe as accountants' territory. Some 35 years ago, I could not face training as an accountant and went to business school instead. Accountants are very dry.
 The clause introduces amendments to the loan relationship rules, which we shall come to when we consider schedule 8. Three main areas are covered. The first is a new rule that provides for an exit charge when loan relationships assigned between connected parties are taken out of the UK tax net. I shall comment on our concerns that the arrangements proposed will not work in the UK following the de Lasteyrie ruling. 
 Secondly, there are amendments to the late interest rules. They are intended to prevent companies in certain circumstances from claiming an accruals tax deduction for interest not paid within the 12-month period. Here we have concerns that the Government have not fully addressed some of the underlying problems. Thirdly, there are amendments to the bad debt relief rules that clarify the position of the parties in various stages of insolvency proceedings. In the main, those arrangements will work satisfactorily. 
 Question put and agreed to. 
 Clause 48 ordered to stand part of the Bill.

Schedule 8 - Loan relationships: miscellaneous amendments

Howard Flight: I beg to move amendment No. 53, in
schedule 8, page 285, line 38, leave out 'from' and insert 'from— 
 (a)'.

John Butterfill: With this it will be convenient to discuss the following amendments: No. 54, in
schedule 8, page 285, line 41, at end insert 
 '; or 
 (b) being deemed to be controlled by another company, by virtue of section 416(2) of the Taxes Act 1988, where control is exercised by the general partner of a CIS limited partnership'.
 No. 55, in 
schedule 8, page 289, line 4, at end add— 
 '8 (1) Section 87 of the Finance Act 1996 is amended as follows. 
 (2) In subsection (5A) (cases where a partnership is a creditor or debtor in a loan relationship) in the closing words, for the words from ''a limited partnership'' to the end of the subsection, substitute ''a CIS limited partnership''. 
 (3) After subsection (5A), insert:— 
 ''(5AA) In this section— 
 ''CIS limited partnership'' means a limited partnership 
 (a) which is a collective investment scheme, or 
 (b) which would be a collective investment scheme if it were not a body corporate. 
 ''collective investment scheme'' means ''a collective investment scheme within the meaning of section 235 of the Financial Services and Markets Act 2000''. 
 (4) These amendments have effect for accounting periods ending on or after 13th December 2003. 
 9 (1) Section 87A of that Act is amended as follows: 
 (2) In subsection (3) (partnerships involving companies) in the closing words, for the words ''a limited partnership'' to the end of the subsection, substitute ''a CIS limited partnership''. 
 (3) After subsection (3), insert:— 
 ''(4) In this section— 
 ''CIS limited partnership'' means a limited partnership 
 (a) which is a collective investment scheme, or 
 (b) which would be a collective investment scheme if it were not a body corporate. 
 ''collective investment scheme'' means a collective investment scheme within the meaning of section 235 of the Financial Services and Markets Act 2000''. 
 (4) These amendments have effect for accounting periods ending on or after 13th December 2003. 
 Interpretation of references to major interests 
 10 (1) Paragraph 20 of Schedule 9 to that Act is amended as follows: 
 (2) In subparagraph (5) (partnerships involving companies) in the closing words, for the words from ''a limited partnership'' to the end of the subsection, substitute ''a CIS limited partnership''. 
 (3) In subparagraph (6) in the closing words, for the words from ''a limited partnership'' to the end of the subsection, substitute ''a CIS limited partnership''. 
 (4) After subparagraph (6), insert— 
 ''(6A) In this paragraph— 
 ''CIS limited partnership'' means a limited partnership 
 (a) which is a collective investment scheme, or 
 (b) which would be a collective investment scheme if it were not a body corporate. 
 ''collective investment scheme'' means a collective investment scheme within the meaning of section 235 of the Financial Services and Markets Act 2000''. 
 (5) These amendments have effect for accounting periods ending on or after 13th December 2003.'.

Howard Flight: Our amendments and the next two cover crucial issues under the schedule. With your permission, Sir John, I shall include in my comments on these amendments any minor comment that I might have made in a debate on the whole schedule.
 The amendments to the bad debt relief rules for debts between companies that were connected but became unconnected as a result of insolvency proceedings are the third part of the territory covered by the schedule. If companies are connected, the bad debt write-off is non-deductible on one side and non-taxable on the other. However, that is not the case when companies are unconnected. There is a gap in the existing rules that means that it is possible for a one-sided tax effect to arise because of a lack of clarity on which arrangements left companies unconnected. Schedule 8 clarifies in detail the rules governing connection. We have no perceived problem with the rules. Indeed, because they clarify the conditions under which release of a debt can be made without a taxable credit arising on the debtor in certain insolvency proceedings, we view them as helpful. 
 Amendments Nos. 53 to 55 relate to the late interest rules, which are highly technical. The Government's changes are split into two parts. According to the boasts of the Inland Revenue briefing note, the first makes changes to put beyond doubt a point of concern for the venture capital industry. Many believe that the Government's proposals in paragraph 2 will not achieve the desired objective in relation to investments by private equity funds that are not collective investment schemes. They are bodies corporate even though they are limited partnerships. 
 The point of concern revolves around whether companies owned by private equity partnerships could deduct interest on their loans from those partnerships on an accruals basis, even if the interest were rolled up or not paid within 12 months from the end of the accounting period, and arose because the rule affects interest paid by a close company. 
 Most private equity investments are treated as close companies, because each private equity investor must attribute all the partnership interest to itself to work it out. The Bill introduces a measure that exempts a partnership from the need to attribute interest, which the industry greatly welcomes, but concern remains that the general partner of the private equity partnership could still make the partnership close because of the control that it exercises on behalf of the other partners. Amendments Nos. 52 and 53 would extend the definition of the collective investment scheme-based close company to cover that point. 
 Another concern relates to the same provisions. Customarily, private equity groups used a two-tier structure, which ensured that private equity investment could deduct interest on an accruals basis. Following the Finance Act 2003, the view was that that was no longer effective unless the creditor was a collective investment scheme, as defined in the Financial Services and Markets Act 2000. That carve-out has been helpfully supplemented by the Bill, with another small exception. 
 The Government's proposed exemptions may remove the CIS-based companies when the creditor is a participator, but they do not seem to do that when the creditor has control of the company or a major interest in it. I am told that there is a common circumstance in which a general partner receives a substantial amount of the income from investments in periods during which there is no capital realisation and when the partner could be deemed to control, or have a major interest in the investment. We therefore propose that the exemption for CIS limited partnerships should be extended to situations in which the partnership controls the major interest, and not only where it is a participator. Amendment No. 55 seeks to address that issue.

Dawn Primarolo: Good morning, Sir John.
 I shall respond to the amendments tabled by the hon. Member for Arundel and South Downs (Mr. Flight) by putting into context schedule 8, which makes changes to legislation on loan relationships and derivative contracts that have been identified in the post-implementation consultative group, of which the hon. Gentleman is aware. It deals with some loopholes that have emerged since 2002, covers areas such as the treatment of certain venture capital limited partnerships by relaxing further an anti-avoidance rule that had an unintended effect on those partnerships, and deals with companies in insolvency proceedings by extending the circumstances in which they can avoid being taxed on imaginary profits. It also covers companies that emigrate or move assets from a permanent establishment by ensuring that tax is charged on profits accruing up to the date of the move, and covers the major interest test for 
 deciding if companies are connected and so receive special tax treatment. As the hon. Gentleman said, this is a highly complex area of tax law. 
 It is the Government's view that, together, amendments Nos. 53 and 54 create an unjustifiable new category of loans that can be exempted from the late interest anti-avoidance rules. The late interest rules prevent a tax deduction for interest that has not been paid within 12 months of the end of the accounting period, and they apply where the lender and borrower are connected or under common control. 
 Amendments Nos. 53 and 54 add a completely new category of venture category funds whose loans would be exempt from the late interest rule. That new category covers limited partnerships funds, where the late interest rule applies because the general partner is the only partner who can manage the partnership. By excluding loans from those funds from the late interest rules, the amendments seek to disregard the central role of the general partner. 
 The Government are proposing changes that do no more than put beyond doubt the circumstances in which the late interest rules are set aside for loans made under limited partnership venture capital funds. One change makes sure that the existing exemption covers some of the foreign partnerships that the industry argued are otherwise excluded because they have some corporate characteristics. The other change stops some loans made by venture capital funds from coming under the late interest rules as a result of an individual being a partner in the fund. We consider that those changes go as far as is needed to address the difficult areas of foreign legal concepts, and cases where individuals are partners in such funds. As the hon. Gentleman said, the changes have been welcomed by the industry. 
 I recognise the point that the hon. Gentleman and the industry have been trying to make, but I am trying to explain the difficulties to the Committee. The amendments represent a significant step beyond the clarification of the existing exemptions from the late interest rules that is proposed by the Government. They go to the heart of the concept of control, which is used widely in the Taxes Act 1988 as a trigger for anti-avoidance rules. I am not minded to take this step because of the risk of weakening the rules; to do so would carry significant and unjustifiable risks for the Exchequer. I entirely accept that it is a complex area, but as a Minister I am clearly making the judgment on advice from my officials. Although we listen carefully to what the venture capital industry is saying, we cannot allow the breach of wider rules.

Howard Flight: I want to go back to something that the Minister said a few minutes ago, about the general partner having a lot of control over the private equity companies that they manage. They have that control as the investment manager on behalf of the other investors, and not in the normal context of controlling a close company. I trust that she would agree that it is inappropriate for the requirements to apply in that situation. If she does not like our amendments and
 thinks that they go too far, how else does she hope to deal with the issue?

Dawn Primarolo: As I tried to explain, the rules that were set in 2002 were widely welcomed and are working well. Discussions with the venture capital trust industry are continuing and a number of issues are being raised. The role of the general partner is at the heart of a number of issues in the tax system. It is one thing to identify an issue for a particular industry. However, I have to ensure that we do not allow a particular industry or sector to operate in a way that we did not allow anywhere else, for good reason, under the Taxes Act and other legislation. Amending the control tests, even narrowly as suggested in amendments Nos. 53 and 54, is not appropriate, because it would risk weakening existing legislation that applies elsewhere.
 It is not within the gift of Government—we would be challenged—to say that a particular industry could work in one way but that everyone else could not. I have to pay attention to the general rules. The hon. Gentleman will understand that a relaxation of the control test in one part of the system will cause significant problems across the board. I think that he is well aware that dialogue between the Inland Revenue and the venture capital trust industry continues. It has raised the matter with us, but what he suggests is not appropriate and cannot be done. He asks how else I would do it. Frankly, I cannot give him an answer. The fundamental point is what happens elsewhere in the tax system. 
 I turn to amendment No. 55, on which I might be a little more helpful, although I do not want to raise the hon. Gentleman's hopes—I am not going to accept it; I thought it best to give that caveat, just in case. It seeks to extend the application of the new definition of a collective investment scheme limited partnership to areas of legislation beyond the application of the late interest rules. 
 As I said earlier, when outlining the provisions of schedule 8, the Government propose a change that puts beyond doubt the circumstances in which the late interest rules are set aside when a limited partnership venture capital fund has invested in a close company. We consider that the changes go far enough to address difficult definitional areas, and they are welcomed by the industry. 
 To the extent that there remain areas of difficulty, the Revenue will continue discussions with the British Venture Capital Association , with a view to resolving the difficulties through revised guidance. I confirm that the existing clarification in Revenue guidance will not be withdrawn. Concern was expressed by the industry that that guidance would be withdrawn as a consequence of schedule 8, but it will not be. 
 I hope that the hon. Gentleman agrees that we are doing our best to respond to the particular issues raised by the industry, but we clearly have to draw a line. We are not going to allow, nor should we, the breach of other legislation. I hope, at least for now, that the hon. Gentleman considers the matter to have 
 had a good airing and that he will withdraw the amendment. If he presses it to a Division, I shall ask the Committee to reject it.

Howard Flight: I am pleased to note the Minister's comments on amendment No. 55, which make it clear that the existing guidance will continue, and she broadly acknowledges the issues raised by amendments Nos. 53 and 54. I repeat that, to my mind, the essence of the point is simple, which is that a general partner managing a venture capital portfolio is doing a professional rather than a close company job. Somehow or other, a method needs to be arrived at to resolve the problem.
 I take the Minister's point that our amendments could have too wide an implication. In a sense, to consider the matter the other way round, the moral is that the industry cannot use partnership structures, and would have to structure itself differently, which is broadly undesirable in the territory of venture capital. I will withdraw the amendment on the basis that the points have been picked up, but I hope that the Revenue and the Minister will find some way to deal with the niggling little problem that has not yet been resolved. I beg to ask leave to withdraw the amendment. 
 Amendment, by leave, withdrawn.

Howard Flight: I beg to move amendment No. 52, in
schedule 8, page 287, leave out from beginning of line 35 to end of line 27 on page 288.

John Butterfill: With this it will be convenient to discuss amendment No. 56, in
schedule 9, page 289, line 25, leave out paragraph 3.

Howard Flight: The most significant problem arising from the schedule is the exit charge imposed on loan relationships that are taken out of the UK tax debt. I assumed that that aspect of the measure was to deal with the probable European Court of Justice ruling in the de Lasteyrie case. Putting that in its widest context, the door is wide open for a European Union country to lower their company tax rates, so that companies base themselves there and not in another EU country. In a sense, Ireland has already done that. I support tax competition, but all the gates have been left down, which will be a big problem for UK corporate tax revenues. As I said on Second Reading, that is a larger potential problem for the Revenue with regard to loss of revenue than some of the anti-avoidance measures that the Bill makes so much of.
 The exit charge is a deterrent for companies wishing to move to the UK, and is one of the levers to stop companies basing themselves where corporate tax rates are lower. From 17 March this year, if a company ceases to be resident in the UK, or permanently established here, it signs its loan relationship assets and liabilities in such a way that they are no longer held for the benefit of a UK permanent establishment. The company will be treated as if it were assigned, and had then immediately reacquired its assets and liabilities at open market value. That could result in a substantial exit charge if the loan assets are sitting at a profit. 
 The Law Society, the Chartered Institute of Taxation and others have issued comments that advise that the new provisions are contrary to the principles established in the recent ECJ de Lasteyrie case. That case related to a French individual who moved his fiscal domicile to Belgium. Under French rules, he was immediately subject to a notional capital gain on his shares. The ECJ held that the French exit charge rules were contrary to freedom of establishment. Since that case, the EU has asked Germany to amend its exit rules, which it argues are also contrary to the freedom of establishment. The EU is also reviewing the rules in other member states. 
 If the proposals are deemed illegal under EU law, there is not much point in the Government implementing them. Amendment No. 52, which would delete the exit charge rules, is in essence a probing amendment, tabled as if to say, ''If they don't work, there ain't much point in having them.'' The Dutch, Germans, Danish and French have all raised objections about the erosion of the tax base and fiscal cohesion and control, but those were roundly rejected by the ECJ. If the rules come under attack from the EU, what will the Government's defence be? If the answer is anti-avoidance, the Government should be reminded that the Advocate-General in the de Lasteyrie case accepted that the need to prevent tax avoidance was a justification for a restriction of fundamental freedoms only if it were specifically targeted towards the relevant fiscal advantage. Our advice is that the exit charge appears too widely drafted to satisfy that requirement. I would be interested to hear how the Paymaster General thinks that she is going escape, following the de Lasteyrie precedent. The EU seems to be undermining her objectives. 
 Amendment No. 56 relates to schedule 9 and essentially makes the same point, but in a different context.

John Burnett: I, too, welcome you, Sir John.
 We are debating a further encroachment on the UK's ability to alter its tax laws. That ability is circumscribed by European Union law. The intervention could be described as benign, because, as has been said, the de Lasteyrie du Saillant case made it clear that it is unlawful under EU law, being contrary to the freedom of establishment, to impose a penalty or an exit charge on loan relationships taken out of any EU tax regime. 
 The Law Society has suggested an amendment that is rather different from amendments Nos. 52 and 56. It takes the view that there is a serious risk that new paragraph 10A is contrary to EU law for the reasons that I have given. The judge at the European Court of Justice found that the French exit charge could not be justified on the grounds that it was designed to prevent tax avoidance, unless it was specifically targeted at artificial arrangements. The Law Society has suggested a different amendment, which, unfortunately, is not up for debate. Nevertheless, I would be delighted to hear 
 the Paymaster General's comments on it. It is a finesse on the amendments that we are debating. 
 The Law Society takes the view that the following addition could get round the problem, and I present it as a constructive suggestion. It says that new paragraph 10A 
''shall not apply unless the avoidance of a liability to corporation tax was the main purpose or one of the main purposes of the company ceasing to be resident in the United Kingdom or the asset or liability ceasing to be held for the purposes of a permanent establishment in the United Kingdom.''

Michael Jack: Will the hon. Gentleman give way?

John Burnett: Of course I will give way to a distinguished former Financial Secretary.

Michael Jack: With a build-up like that, I hope that the question is not disappointing. In suggesting the wording from the Law Society, will the hon. Gentleman expand a little on the tests that might be employed to determine whether the action to be taken by the company was in pursuit of the avoidance that lies at the heart of his proposals?

John Burnett: The right hon. Gentleman suggests that the Law Society makes amendments to encourage further work for lawyers. I am not sure whether that is the thrust of what he says, but as he knows, there is a welter of cases about what is and what is not the motive for tax avoidance.

Howard Flight: Recalling our debate on the disclosure of VAT avoidance schemes, I wonder whether a further crafting of the proposals could relate to the benefits rather than the purpose, which is the underlying principle that the Government will seek to use later on.

John Burnett: We did have an interesting debate on the subject of benefits and purposes and we discussed other leading tax avoidance cases, not least Ramsay and Furniss v. Dawson.
 There is a flaw in new paragraph 10A, and the Law Society has made a proposal to overcome it. What advice have Ministers received about the enforcement, or otherwise, of the provision?

Dawn Primarolo: I shall ask the Committee to reject the amendments. They would stop the introduction of a new rule—fair value accounting to loan relationships and derivative contracts of companies in their last accounting period prior to becoming non-resident. Fair value accounting recognises profits and losses arising from changes in the market value of the contracts.
 Paragraph 5 of schedule 8 and paragraph 3 of schedule 9 introduce the rule, and it applies to companies that cease to be UK residents in circumstances where their loan relationships and derivative contracts are accounted for on an authorised accrual basis. The rule also applies to the transfer of non-UK resident companies' loan relationships and derivative contracts from their UK-permanent establishment. 
 The fair value rule is even-handed in its application. It will allow relief for a loss at the point of emigration to the extent that that relief has not already been 
 claimed, and it will also tax gains. In addition, it complements the existing rules that ensure continuity of treatment within groups of companies for loan relationships and derivative contracts that are accounted for on an accruals basis. The rules are intended to allow a group's commercial freedom to transfer such contracts between group members without incurring tax. 
 It will not come as a surprise to the Committee that I reject the view that the proposed fair value rule is in contravention of the EC treaty. It can be distinguished from the French exit charge on several grounds. The Lasteyrie decision concerns a specific French income tax charge on individuals that the ECJ found to be disproportionate—a point to which the hon. Gentleman referred with regard to anti-avoidance. It is not, as a matter of principle, a blanket prohibition on all exit charges. 
 The decision is not applicable to the proposed charges to UK corporation tax, which is a charge on companies. The fair value rule exists to tax only deferred gains in a company's final accounting period within the charge for corporation tax.

John Burnett: Will the Paymaster General give way?

Dawn Primarolo: If I could just finish that point, I might be able to answer the hon. Gentleman's question on the ECJ ruling in the French case. [Interruption.]

John Butterfill: Order. The right hon. Lady must be heard.

Dawn Primarolo: Thank you, Sir. John.
 The fair value rule does not create a new tax charge. It simply requires that one recognised method of accounting, fair value, is used in place of another recognised method, accruals, when a corporation tax computation must be made. It ensures that UK companies are properly taxed on the full profits they have made while they are in the UK on loan relationships and derivative contracts. To do otherwise would be to give them an unfair advantage over other UK incorporated companies. That is very clear, and hon. Members should keep that in mind. 
 The hon. Member for Arundel and South Downs referred to several countries, including Germany. Germany has been asked to amend its exit charge on individuals, not companies. The issue that we are debating is whether deferred taxes are paid before a company leaves the UK. 
 Before I give way to the hon. Member for Torridge and West Devon (Mr. Burnett), I wish to address the question about the Law Society, companies that are targeted for avoidance and the motive test. The motive test simply is not appropriate for a measure that is intended for general application. The Government do not accept that the ECJ decision in the French case applies to the legislation proposed in the clause and schedule. The measure provides a clear rule on the computation of profits for a company's final accounting period prior to its ceasing to be resident in the UK. The use of fair value, which is a recognised accounting method, is the most suitable for that. 
 I shall give way to the hon. Gentleman, but perhaps he could explain to the Committee why he thinks it fair that companies should be allowed to leave the UK without having paid deferred tax. If he does not think that that is fair, why is he opposing the proposals in the schedule?

Hon. Members: Go on.

John Burnett: I will not be pilloried in this way. The Paymaster General is traducing me. I was making a constructive suggestion, because I thought that she was in error. I am not yet wholly convinced that her explanation is adequate to overcome the problems that have been identified by the Opposition. I have a simple question for clarification. She said that the charge will apply only to deferred gains. Does she mean by that gains formerly rolled over, or does she mean all gains on all assets?

Dawn Primarolo: The fair value method will ensure that the company concerned pays the corporation tax due in the UK on the gains at that date. Every other corporate body in the UK is expected to do that, subject to corporation tax rules. The spectre raised by the hon. Gentleman is that in some way the ECJ ruling in the French case is pertinent to the schedule. I have explained to him that it is not. The schedule applies not to individuals but to companies. It is about ensuring that they pay the tax that they owe to the UK.

John Burnett: Companies can roll over for capital gains tax purposes. I hope that the Paymaster General can enlighten the Committee on that important point.

Dawn Primarolo: I think that I made it clear that the UK does not accept that the judgment in that case applies to these provisions and that it would be unfair if companies were able to use migration just to extinguish deferred tax liabilities. Some of those may have arisen when a loan relationship or derivative contract was owned by another group member, which created unfairness compared with other taxpayers. The new measure provides a clear rule for the computation of profits for the final accounting period of a company prior to its ceasing to be resident in the UK. Using fair value—a recognised accounting method—is the most suitable way to do that.
 The proposition that the hon. Members for Torridge and West Devon and for Arundel and South Downs made in their contributions was that they do not believe that we achieve that objective because of the ECJ decision in the French case. I have explained—so I presume that they accept the underlying principle—why the suggestion that the ECJ case is relevant is not true and why the proposals are entirely fair.

Howard Flight: I could not agree more with what the Paymaster General said from the point of view of a British person. I think that it is debatable whether the fact that Lasteyrie applied to an individual and not to companies rules out its relevance, because it seems to me that a judgment of principle was made.
 The point that the Paymaster General is not answering is this: if the issue is considered from the 
 perspective of the ECJ, the problem is that the ECJ does not regard transferring to another EU base as migrating. Its attack is that anything that creates fiscal penalties merely because of migration within the EU, which it regards as one country for the purposes of tax, has to be wrong. If the Government do not accept that Lasteyrie, or the next judgment, means that the ECJ is going to attack that principle, they are naive. It is about time that the Government considered other tactics to deal with the ECJ attacks on the British corporate tax base.

Dawn Primarolo: In earlier debates, the hon. Gentleman raised the spectre of the ECJ, saying that its decisions could impinge on the UK corporate tax system. What I am saying to him is that the view of the Government—regardless of whether he thinks that it is a debatable view—is that the case that he cites is not relevant in those circumstances for the reasons that I have given.
 I return to the major point. The proposals ensure that the full amount of commercial profit is taxed and that the full amount of any commercial loss is recognised in the accounting period prior to the company going offshore. That is interesting. We can discuss the views of various members of the Committee about whether the ECJ decision in the French case will impinge on it, but the advice that the Department has given me is very clear. I have explained the principles. I understand the concerns that the Law Society and others have expressed, but again I assert that the issues that have been raised are not relevant.

Michael Jack: Given that there are similarities in corporate taxation in the United Kingdom and other member states, does the same general rule apply to companies from Germany or France, for example, that cease trading in their respective countries and come in the opposite direction? The implication is that such a company would have to pay its corporate taxes before moving here.

Dawn Primarolo: In answer to the question from the hon. Member for Arundel and South Downs and with regard to what the European Court of Justice asked Germany to do as a result of the judgment, it is interesting that Germany has been asked to amend its exit charge on individuals, not on companies. That reinforces the very point that I am making.
 We have had an interesting debate. I hope both that I have made clear the advice of the Government and the principles that we are pursuing, and that the hon. Gentleman will withdraw the amendment. However, if he presses it to a vote, I will ask the Committee to oppose it.

Howard Flight: I hope that the Minister is right, because I am perhaps even keener than she is to protect UK tax revenues, which we look forward to managing in the near future. She made a clear case as to why the Government's view is that they may escape the judgment of the de Lasteyrie case, and I hope that she is correct.
 As I said, the intention behind the amendment was to probe the Government, which is quite the reverse of wishing to attack the measures. However, I remain deeply concerned that, if not Lasteyrie, there will be 
 something else sooner or later. It is time for British Governments to develop a somewhat wider strategy on the issue, or we shall keep finding one attack here and another attack there, and various aspects of corporate tax revenue will be under threat. We have had a focused discussion, so I beg to ask leave to withdraw the amendment. 
 Amendment, by leave, withdrawn. 
 Schedule 8 agreed to.

Clause 49 - Derivative contracts: miscellaneous amendments

Question proposed, That the clause stand part of the Bill.

Howard Flight: Briefly, following the point that we have just discussed about derivative contracts, the clause also makes provision for a slight change to the calculation of the profits and losses of an open-ended investment company, otherwise known as an OEIC.
 As things stand, capital profits and losses arising from a derivative contract during a period are taxed. Those capital profits and losses are picked up from the statement of total return, which, in turn, was included in the OEIC's accounts for the year under the statement of recommended practice that the Financial Services Authority issued in 2000. The offending provision referred to any amendment brought to the statement by the FSA. As I understand it, the FSA did not issue the update; rather the Investment Management Association did so. The words issued by the FSA have therefore been removed. 
 The clause and schedule 8 amend rules on derivatives entered into for an unallowable purpose, which were introduced under the Finance Act 2002. The changes are intended to make the rules work as they were originally supposed to, so that much of the debits and credits arising on the contract from unallowable contracts are taken out of the profits and losses that are taxed under the rules. If the debits referable to the unallowable purposes are higher than the credits, they can be carried forward and offset against credits in future periods. Previously, the net debits could be offset directly against the credits, but that has been changed to ensure that the net debits may be offset against credits only after other allowable debits have been offset. That technical change clarifies how the rules work. It should have been included in the previous legislation, so it is both necessary and welcome. 
 Question put and agreed to. 
 Clause 49 ordered to stand part of the Bill. 
 Schedule 9 agreed to. 
 Clause 50 ordered to stand part of the Bill.

Clause 51 - Use of different accounting practices

Howard Flight: I beg to move amendment No. 96, in
clause 51, page 58, line 11, leave out second 'and'.

John Butterfill: With this it will be convenient to discuss amendment No. 97, in
clause 51, page 58, line 14, at end insert 
 ', and 
 (e) the sole or main benefit of the transaction or the series of transactions was the obtaining of the tax advantage.'.

Howard Flight: Hon. Members have raised one or two technical issues. Once international accounting standards—IAS—are in force, companies will be required to prepare consolidated accounts, and hence the accounts of the holding company, under IAS. However, they may choose to continue to prepare UK generally accepted accounting practice—GAAP—accounts for some or all subsidiaries. They may well choose to do that for non-tax reasons, such as the level of work involved.
 The clause is broadly welcomed by business. It is seen as the inevitable price of allowing companies a free choice to use GAAP at solo company level—a sort of burden on business. The clause applies a mechanical test to determine whether a transaction between two companies that use different accounting practices should be adjusted for tax purposes. I believe that the Revenue has already been asked to explain why the test should not be whether there are genuine commercial reasons for the adoption of different accounting practices. 
 The clause is a necessary response to the decision to allow companies the choice to use GAAP at a solo level, but it has been pointed out that it could have been better drafted. Where it applies, it forces a company using IAS back on to UK GAAP for tax purposes if a tax advantage would otherwise be obtained. There is no motive test, so the taxpayer gets the worst of both worlds. For example, suppose that two group companies undertake a derivative transaction and accruals are accounted by one company under UK GAAP, but marked to market by the other under IAS. If the difference produces a tax disadvantage, it stands, but if it produces an advantage, it is cancelled by forcing the second company on to UK GAAP. 
 It has been argued that that aspect could be removed by introducing a test that the advantage had to be one of the main foreseeable benefits when the transaction was implemented. That is what we seek to do with the amendments. 
 The point has also been made that, although what I have just described is unfair on the innocent, the measures are potentially weak against a determined avoider, as they apply only between two companies in the same capital gains tax group. They could be de-grouped quite easily while remaining under the same effective ownership and control. The arrangement leaves out an intra-IAS arbitrage opportunity deriving from clause 50(3) and applies only to transactions or series of transactions, not to companies with different existing profiles, which can be used as the basis for arbitrage.

Quentin Davies: On a point of order, Sir John. I should be grateful for your guidance about whether this is one
 of those occasions on which you intend the substantive discussion of the purpose of the clause to take place under the heading of the amendment. I have been listening to my hon. Friend carefully and his amendment goes to the heart of the purpose of the clause. Alternatively, do you intend that there should be a clause stand part debate?

John Butterfill: I do not think that the hon. Member for Arundel and South Downs strayed particularly wide, in his remarks, of amendments Nos. 96 and 97, although those do, as the hon. Gentleman suggests, go to the heart of clause 51. I am perfectly happy, if the Committee wishes, to allow remarks on the amendments to be extended a little further, on the basis that we shall then have no stand part debate. I see nods of assent, so we shall proceed on that basis.

Quentin Davies: Thank you, Sir John.
 First, I apologise, because last week—purely as a result of a slip in memory—I did not, as I did on Second Reading, declare my interests, in so far as they might be considered relevant to the Finance Bill. I am, and have been for a number of years, an adviser to the Chartered Institute of Taxation. The institute of course has no position on or interest in any particular tax measure, but nevertheless I should declare that interest. 
 I am also a director of Vinci—both the main board, Vinci SA, and the UK subsidiary, Vinci plc. As a result I shall not be making any contribution on matters relating to the construction industry, which we shall reach shortly. I am also a member of the council to the governing board of Lloyd's, so I shall have to restrain my intellectual interest in that subject too, when we get to it. I have no interest as an underwriter—I am not and never have been a name. 
 The clause is interesting in several ways. As my hon. Friend the Member for Arundel and South Downs explained, it has the curious effect that, although the Government have introduced legislation—following a European directive—giving non-listed companies the option of moving to IAS or staying with GAAP, there is clearly, in this case, a one-way bet in favour of the Revenue. If the option is exercised so that within a group of companies a tax advantage might arise, the clause will override it; if it is exercised so that a tax disadvantage arises to a company, the tax disadvantage remains. That is a slightly curious state of affairs. 
 What I have described highlights the artificiality of tax accounting in this country. That is a very wide subject, which I am sure the House should have an opportunity to debate—not this morning, of course. It is clearly at the heart of the economic impact of the tax system in this country. The system is in many cases perverse and I remind the Committee that other EU countries—Germany, for example, which is a very sophisticated economy—base their tax accounting on normal accounting standards. For a long time, and before the introduction of IAS, German companies have been expected to present to the tax office—Finanzamt, in their case—exactly the same accounts as they present to their shareholders. Those accounts are based on accounting principles, which are taken, 
 expected, hoped and intended to be principles that follow economic reality as far as possible, because that is the object of good accounting. 
 That system is an enormous advantage, whereas in this country we continue to have the absurd artificiality in which people must produce completely separate accounts on a completely different basis for the tax system, which has nothing to do with economic reality. Now we have an even greater anomaly whereby, even if people present accounts using an option allowed under accounting law, they can be left at a disadvantage if a disadvantage arises, and without any benefit if some benefit arises. There is no doubt that it is an anomalous and curious situation. 
 I have two questions for the Paymaster General, which need to be answered before the Committee takes a decision on the clause. One is about a practical consequence and the other is a matter of interpretation on something that I do not understand. I hope that when I have heard the explanation in a few minutes I shall do. 
 First, what is to stop companies getting round the clause by de-grouping for capital gains tax purposes? It is perfectly possible and not difficult, and they would get the benefit—if there was a tax benefit to be obtained—of exercising the options of GAAP and IAS. Are the Government wasting their time drafting the clause? In practice, is it not true that if a group of companies could obtain a tax advantage by exercising that option, they would simply de-group to do so? 
 Secondly, there is a question of interpretation of the text.

John Burnett: There could be considerable tax difficulties if the companies de-grouped and held-over, roll-over or inter-group gains were brought into charge.

Quentin Davies: Certainly. A company faced with the application of this clause to its tax affairs would have to take a view on balance of its aggregate tax position and the extent to which that position would be improved by exercising the options of whether to move to IAS or stay with GAAP and whether to stay grouped or to de-group. It would have to take a rational decision.
 Companies have a responsibility to their shareholders to take a rational decision in light of any change in the law. The provision will constitute a change in tax law that might be very material to them. The hon. Gentleman is absolutely right: they will have to take those other considerations into account. 
 The existence of the option will negate the impact or the benefit to the Revenue, which is presumably the purpose of loading already extremely complicated Finance Acts with this new provision. We ought to hear the Paymaster General's response to that.

John Burnett: I am getting at the fact that the ability to circumvent the clause will be very limited. It is wrong in principle that the Revenue gets both ends of the stick and a hunk out of the middle. Does the hon. Gentleman agree with that?

Quentin Davies: Yes, I totally agree. There is far too much of that one-sided drafting in Finance Acts, and
 the hon. Gentleman and I are at one in questioning the good sense of introducing the clause. A transformation cannot take place overnight, but if I were ever in a position to influence matters I would want to move in this direction: our tax law should be gradually aligned with economic reality.
 Where we introduce IAS—an extremely good move—compulsorily for listed companies, and voluntarily for other companies, which is right because we do not want to impose additional compliance burdens on the broad mass of companies in this country, and the move to IAS should be evolutionary not revolutionary, we should allow companies to benefit from an increasingly rational accounting system. 
 Companies should be taxed on real economic profits and not on artificial profits computed by the Revenue—or compulsorily computed by companies for the benefit for the Revenue—on the basis of what is, as I have said, an artificial system. I make it clear that that is my agenda. It seems to me from the body language that I am not alone in the Committee in feeling that way. I am reassured that that is the case. 
 This is a matter of pure interpretation, and I may be being extremely stupid about it, which the Paymaster General will enjoy telling me if that is the case, but I must assume that I am not alone among the 56 million people in this country who may be affected by tax law at some stage in finding the clause difficult to understand. I refer to subsection (4), which says: 
''A series of transactions is not prevented from being a series of transactions involving company A and company B by reason only of the fact that one or more of the following is the case—
(a) there is no transaction in the series to which both those companies are parties''.
 That is reasonable. It may well be, if only one of the relevant companies in a group is a party to a transaction, but not the other, that some tax benefit is generated. 
 The subsection continues: 
''(b) that parties to any arrangement in pursuance of which the transactions in the series are entered into do not include one or both of those companies''.
 That is most extraordinary. In other words, there could be a transaction not involving either of those group companies, or any company in that group, that would give rise to a tax charge. That must be an absurdity. The Paymaster General is about to tell me that I am being stupid and have misunderstood the clause, but I repeat that it says: 
''A series of transactions is not prevented from being''
 taxable in that way, or having the clause applied to it, even if neither of the companies involved has been a party to that transaction. That seems to me most extraordinary and I hope that the Economic Secretary can clarify.

John Healey: I welcome the fact that the hon. Member for Arundel and South Downs has confirmed that the clause is broadly welcomed by the industry. I am aware of the concerns that he raises about its being too wide. Amendments Nos. 96 and 97 reflect those
 worries. I say to him that it is not as wide as it looks or as weak as he fears.
 I turn to the points that the hon. Gentleman and the hon. Member for Grantham and Stamford (Mr. Davies) raised about the provisions being potentially weak. The concern was that they might allow companies to de-group while remaining under the same ownership and control. Our view is that it is unlikely that companies would de-group simply to exploit any benefit that might arise from using both the IAS and the UK GAAP, because any such rearrangement might have other, possibly disadvantageous, tax consequences in the first place. In any event, UK GAAP will soon be converging with the IAS, making any possible benefit from de-grouping potentially expensive and certainly short-lived.

Quentin Davies: The Economic Secretary has made two comments that I must take him up on. One is that he thinks it unlikely that companies would de-group, because they might have other reasons not to do so. That is precisely the point already put to me by the hon. Member for Torridge and West Devon. I have already answered it.
 The second point is a particularly curious one, because if it is true that, since everybody is moving rapidly to IAS, it is very unlikely that the situation will arise that there could be a profitable arbitrage to be made by deciding to remain on GAAP, rather than moving to IAS, the clause is not necessary. The Economic Secretary produces a good argument for saving the public from this additional burden of tax legislation. If he believes his own argument, that the opportunity for such tax arbitrage and tax shopping-around is going to be limited in time, why is he introducing the clause in the first place? If his argument is an argument against mine, it is even more strongly one against his own.

John Healey: The move to international accounting standards is supported across the board by Government and by industry. We are in a transitionary phase, and the clause is necessary to manage that. The answer to the hon. Gentleman's question about de-grouping is that the phase is likely to be brief. Any relative tax advantage that might be gained by using the two standards will be short-lived. The situation that he and the hon. Member for Arundel and South Downs fear is unlikely to arise.

Michael Jack: On a point of detail, would the Economic Secretary touch on the phenomenon of a company that, as a result of these provisions, gains an advantage in one tax area that is cancelled out in another? Does the clause apply?

John Healey: The short answer is no. The clause would not apply in such circumstances.
 I turn to the other concerns that the amendments address. For the clause to apply, the disparity in treatment of the transaction has to be as a result of the use of the two different accounting frameworks—IAS for one company and UK GAAP for the other. An 
 example that is often given is the one cited by the hon. Member for Arundel and South Downs—one company uses mark-to-market or fair value accounting for its end of transaction, such as a loan, and the other uses cost accounting. The difference exists under current UK GAAP and within IAS. It is not caught by the clause. The cases in which IAS and UK GAAP provide a clear difference in accounting treatment of the same transaction are difficult to find. In many ways the legislation is a backstop in case such differences emerge. 
 Amendment No. 97 would create another hurdle that had to be climbed before the clause could operate. It requires that the sole or main benefit of the transaction is the obtaining of the tax advantage. However, the obtaining of a tax advantage from the transaction is not the problem: the mischief comes from the obtaining of a tax advantage from the different accounting treatment of each end of the transaction. The amendment technically misfires. On that basis, I hope that the hon. Gentleman will not insist on it. 
 More generally, may I give some words of comfort to the Committee? The Inland Revenue's guidance on the clause will make it clear when and in what circumstances it expects the test to operate. The guidance will be developed through further discussion with the industry and professional interests, as part of the consultation group and process that the Revenue has established.

Quentin Davies: May I remind the Economic Secretary that I asked him another question that he has not answered? Can he explain the meaning of subsection (4)? As I understand it, it has the perverse effect that companies could be made liable for tax in relation to a transaction to which they are not party. I might own a group of companies, none of which is involved in a transaction, but become liable for tax because a company owned by you, Sir John, undertakes a transaction. That would be absurd, but the Economic Secretary has not explained how the wording of the subsection does not give rise to that interpretation.

John Healey: The wording in subsection (4) is the standard wording that is used in transfer pricing. Transfer pricing was thoroughly discussed under another part of the Bill.

Howard Flight: For a brief period, I was a director of a company that adopted IAS. I thought that it was a disastrous way of communicating information to shareholders. It added some 10 pages of notes to the accounts because of the need to explain to people how they could relate the figures that emerged under IAS to the format that they were generally used to. I agree that the accounting profession and many others welcome the introduction of IAS and some of the principles behind it, but many aspects of it are less than helpful to an understanding of what is going on in a business.
 I am slightly out of my depth in these matters as I am not an accountant, but it seems to me that the Minister is endeavouring to say that the scenario that concerns me, as well as many others, is pretty unlikely 
 to arise, and that the amendments, which might go too far in the other direction, are not justified. I am not entirely clear whether he is also saying that if the situation that I describe were to arise, the intent is that the Inland Revenue guidance should deal with the issue to stop the undesirable double taxation-type effects to which I referred. If he is saying that, there is clearly no need for amendments. If he is not saying that, it is unsatisfactory to put into law a situation of considerable unfairness that may be unlikely but that could, in rare circumstances, come to be. 
 Before I make my final comments on the amendments, I would be grateful if the Minister could clarify his remarks about the Inland Revenue guidance.

Quentin Davies: I was very unsatisfied by the Minister's reply to me about subsection (4). He did not attempt to defend his wording, and did not give the Committee any explanation. Nor did he tell me why my interpretation was wrong. He merely said that the wording replicated the wording somewhere else in tax legislation. I presume that when we come to that wording, we shall be told that we cannot discuss it because it appears in section 170 of the Taxation of Chargeable Gains Act 1992 as amended by the clause. We are going round in circles, with the Government avoiding their fundamental responsibility to explain the rationale behind the wording to the Committee and to the public. I explained why I believe that the wording is susceptible to an extremely perverse interpretation. Indeed, a very perverse understanding of it is the natural reading of the words. I repeat my question: will he explain why the words that I quoted do not bear the interpretation that they appear to have?

John Healey: The rationale is simply that the wording in subsection (4) is the standard wording used in the transfer pricing provisions, which the Committee discussed in full at an earlier sitting that the hon. Gentleman unfortunately did not attend. Had he done so, he might not have needed to raise this point.
 On the narrow and more serious point made by the hon. Member for Arundel and South Downs, his concerns have been raised by others involved in the consultation that the Revenue set up through the consultative groups. We will take account of those concerns. Indeed, the guidance that we will publish following the Committee's deliberations can deal with them.

Howard Flight: I am sad that the concerns expressed by my hon. Friend the Member for Grantham and Stamford have still not been specifically addressed, but I am glad that the Minister has confirmed that the issue that we raise will be dealt with. I beg to ask leave to withdraw the amendment.
 Amendment, by leave, withdrawn. 
 Amendment made: No. 89, in 
clause 51, page 58, line 12, leave out 'paragraph' and insert 'section'.—[John Healey.]
 Clause 51, as amended, ordered to stand part of the Bill.

Clause 52 - Amendment of enactments that operate by reference to accounting practice

Question proposed, That the clause stand part of the Bill.

Howard Flight: It is worth airing some issues on the record, because the clause is somewhat confusingly drafted. Broadly speaking, we have concluded that it will operate in the manner expected, but the Chartered Institute of Taxation is concerned about whether it and others have correctly understood how the formula will work in relation to liabilities. Addressing those concerns will probably require further discussion with the Revenue rather than an amendment.
 The CIT is concerned that the application of the rules to issuers and holders of convertible securities remains unclear, given that section 26 of the Finance Act 2002 does not deal with derivatives relating to shares and that new section 93(5), which is to be included in the Finance Act 1993, might be deleted so that capital gains and allowable losses can be computed in a company's functional currency. 
 Clause 52 has been generally welcomed, for the same reasons as clause 50 was. The regulation-making power intended to enable the preservation of UK GAAP-style hedging is also welcome. However, as I said, there are some drafting difficulties with the clause. 
 Finally, there are specific issues in relation to the discussions that have take place with the Revenue. If a company has a dollar functional currency and incurs a trading loss, will that loss be carried forward in dollars and set against the dollar profit in the following accounting period or translated into sterling and set against the sterling equivalent of the dollar profit in the next accounting period? Clearly, in that context, it could be dollar-dollar, euro-euro or renminbi-renminbi. 
 The question that has been raised relates to paragraph 46 of the explanatory notes, which states that regulations will be made under paragraph 13 of schedule 26 to the Finance Act 2002. Where a corporate investor holds a convertible bond, increases in the value of the embedded derivative will be subject to corporate tax on chargeable gains. The question that has been raised is how the exercise of the option to convert the security into shares will be treated for tax purposes. 
 Debate adjourned.—[Jim Fitzpatrick.] 
 Adjourned accordingly at two minutes to Eleven o'clock till this day at half-past Two o'clock.